A semi-annual coupon bond has a yield of 3% pa. Which of the following statements about the yield is **NOT** correct? All rates are given to four decimal places.

**Question 64** inflation, real and nominal returns and cash flows, APR, effective rate

In Germany, nominal yields on **semi**-annual coupon paying Government Bonds with 2 years until maturity are currently **0.04**% pa.

The inflation rate is currently **1.4**% pa, given as an APR compounding per **quarter**. The inflation rate is not expected to change over the next 2 years.

What is the real yield on these bonds, given as an APR compounding every 6 months?

You just borrowed $400,000 in the form of a 25 year **interest-only** mortgage with monthly payments of $3,000 per month. The interest rate is 9% pa which is not expected to change.

You actually plan to pay more than the required interest payment. You plan to pay $3,300 in mortgage payments every month, which your mortgage lender allows. These extra payments will reduce the principal and the minimum interest payment required each month.

At the maturity of the mortgage, what will be the principal? That is, after the last (300th) interest payment of $3,300 in 25 years, how much will be owing on the mortgage?

**Question 452** limited liability, expected and historical returns

What is the lowest and highest expected share price and expected return from owning shares in a **company** over a finite period of time?

Let the current share price be ##p_0##, the expected future share price be ##p_1##, the expected future dividend be ##d_1## and the expected return be ##r##. Define the expected return as:

##r=\dfrac{p_1-p_0+d_1}{p_0} ##

The answer choices are stated using inequalities. As an example, the first answer choice "(a) ##0≤p<∞## and ##0≤r< 1##", states that the share price must be larger than or equal to zero and less than positive infinity, and that the return must be larger than or equal to zero and less than one.

The expression 'cash is king' emphasizes the importance of having enough cash to pay your short term debts to avoid bankruptcy. Which business decision is this expression most closely related to?

The phone company Telstra have 2 mobile service plans on offer which both have the same amount of phone call, text message and internet data credit. Both plans have a contract length of 24 months and the monthly cost is payable in advance. The only difference between the two plans is that one is a:

- 'Bring Your Own' (BYO) mobile service plan, costing $50 per month. There is no phone included in this plan. The other plan is a:
- 'Bundled' mobile service plan that comes with the latest smart phone, costing $71 per month. This plan includes the latest smart phone.

Neither plan has any additional payments at the start or end.

The only difference between the plans is the phone, so what is the implied cost of the phone as a present value?

Assume that the discount rate is 2% per month given as an effective monthly rate, the same high interest rate on credit cards.

**Question 498** NPV, Annuity, perpetuity with growth, multi stage growth model

A business project is expected to cost $100 now (t=0), then pay $10 at the end of the third (t=3), fourth, fifth and sixth years, and then grow by 5% pa every year forever. So the cash flow will be $10.5 at the end of the seventh year (t=7), then $11.025 at the end of the eighth year (t=8) and so on perpetually. The total required return is 10℅ pa.

Which of the following formulas will **NOT** give the correct net present value of the project?

One and a half years ago Frank bought a house for $**600,000**. Now it's worth only $**500,000**, based on recent similar sales in the area.

The expected total return on Frank's residential property is **7**% pa.

He rents his house out for $**1,600** per month, paid in advance. Every 12 months he plans to increase the rental payments.

The present value of 12 months of rental payments is $**18,617.27**.

The future value of 12 months of rental payments one year in the future is $**19,920.48**.

What is the expected annual **rental** yield of the property? Ignore the costs of renting such as maintenance, real estate agent fees and so on.

You have $**100,000** in the bank. The bank pays interest at **10**% pa, given as an effective annual rate.

You wish to consume **twice** as much now (t=0) as in one year (t=1) and have nothing left in the bank at the end.

How much can you consume at time zero and one? The answer choices are given in the same order.

You have $100,000 in the bank. The bank pays interest at 10% pa, given as an effective annual rate.

You wish to consume an equal amount now (t=0) and in one year (t=1) and have nothing left in the bank at the end (t=1).

How much can you consume at each time?

You are promised **20** payments of $**100**, where the first payment is immediate (t=**0**) and the last is at the end of the 19th year (t=**19**). The effective annual discount rate is ##r##.

Which of the following equations does **NOT** give the correct present value of these 20 payments?

Two years ago Fred bought a house for $**300,000**.

Now it's worth $**500,000**, based on recent similar sales in the area.

Fred's residential property has an expected total return of **8**% pa.

He rents his house out for $**2,000** per month, paid in advance. Every 12 months he plans to increase the rental payments.

The present value of 12 months of rental payments is $**23,173.86**.

The future value of 12 months of rental payments one year ahead is $**25,027.77**.

What is the expected annual growth rate of the rental payments? In other words, by what percentage increase will Fred have to raise the monthly rent by each year to sustain the expected annual total return of 8%?

**Question 535** DDM, real and nominal returns and cash flows, stock pricing

You are an equities analyst trying to value the equity of the Australian telecoms company Telstra, with ticker TLS. In Australia, listed companies like Telstra tend to pay dividends every **6** months. The payment around August is called the final dividend and the payment around February is called the interim dividend. Both occur annually.

- Today is mid-
**March 2015**. - TLS's last interim dividend of $
**0.15**was one month ago in mid-**February 2015**. - TLS's last final dividend of $
**0.15**was seven months ago in mid-**August 2014**.

Judging by TLS's dividend history and prospects, you estimate that the nominal dividend growth rate will be **1**% pa. Assume that TLS's total nominal cost of equity is **6**% pa. The dividends are nominal cash flows and the inflation rate is **2.5**% pa. All rates are quoted as nominal effective annual rates. Assume that each month is exactly one twelfth (1/12) of a year, so you can ignore the number of days in each month.

Calculate the current TLS share price.

A stock is expected to pay the following dividends:

Cash Flows of a Stock | ||||||

Time (yrs) | 0 | 1 | 2 | 3 | 4 | ... |

Dividend ($) | 0.00 | 1.00 | 1.05 | 1.10 | 1.15 | ... |

After year 4, the annual dividend will grow in perpetuity at 5% pa, so;

- the dividend at t=5 will be $1.15(1+0.05),
- the dividend at t=6 will be $1.15(1+0.05)^2, and so on.

The required return on the stock is 10% pa. Both the growth rate and required return are given as effective annual rates.

What will be the price of the stock in three and a half years (t = 3.5)?

The following is the Dividend Discount Model (DDM) used to price stocks:

### P_0 = \frac{d_1}{r-g} ###Assume that the assumptions of the DDM hold and that the time period is measured in years.

Which of the following is equal to the expected dividend in 3 years, ## d_3 ##?

The following equation is the Dividend Discount Model, also known as the 'Gordon Growth Model' or the 'Perpetuity with growth' equation.

### p_0 = \frac{d_1}{r - g} ###

Which expression is **NOT** equal to the expected dividend yield?

The following equation is the Dividend Discount Model, also known as the 'Gordon Growth Model' or the 'Perpetuity with growth' equation.

###p_0=\frac{d_1}{r_\text{eff}-g_\text{eff}}###

Which expression is **NOT** equal to the expected capital return?

**Question 50** DDM, stock pricing, inflation, real and nominal returns and cash flows

Most listed Australian companies pay dividends twice per year, the 'interim' and 'final' dividends, which are roughly 6 months apart.

You are an equities analyst trying to value the company BHP. You decide to use the Dividend Discount Model (DDM) as a starting point, so you study BHP's dividend history and you find that BHP tends to pay the same interim and final dividend each year, and that both grow by the same rate.

You expect BHP will pay a $0.55 interim dividend in six months and a $0.55 final dividend in one year. You expect each to grow by 4% next year and forever, so the interim and final dividends next year will be $0.572 each, and so on in perpetuity.

Assume BHP's cost of equity is 8% pa. All rates are quoted as nominal effective rates. The dividends are nominal cash flows and the inflation rate is 2.5% pa.

What is the current price of a BHP share?

Estimate the US bank JP Morgan's share price using a price earnings (PE) multiples approach with the following assumptions and figures only:

- The major US banks JP Morgan Chase (JPM), Citi Group (C) and Wells Fargo (WFC) are comparable companies;
- JP Morgan Chase's historical earnings per share (EPS) is $
**4.37**; - Citi Group's share price is $
**50.05**and historical EPS is $**4.26**; - Wells Fargo's share price is $
**48.98**and historical EPS is $**3.89**.

Note: Figures sourced from Google Finance on 24 March 2014.

Which of the following investable assets are **NOT** suitable for valuation using PE multiples techniques?

Which firms tend to have **high** forward-looking price-earnings (PE) ratios?

Private equity firms are known to buy medium sized private companies operating in the same industry, merge them together into a larger company, and then sell it off in a public float (initial public offering, IPO).

If medium-sized private companies trade at PE ratios of **5** and larger listed companies trade at PE ratios of **15**, what return can be achieved from this strategy?

Assume that:

- The medium-sized companies can be bought, merged and sold in an IPO instantaneously.
- There are no costs of finding, valuing, merging and restructuring the medium sized companies. Also, there is no competition to buy the medium-sized companies from other private equity firms.
- The large merged firm's earnings are the sum of the medium firms' earnings.
- The only reason for the difference in medium and large firm's PE ratios is due to the illiquidity of the medium firms' shares.
- Return is defined as: ##r_{0→1} = (p_1-p_0+c_1)/p_0## , where time zero is just before the merger and time one is just after.

**Question 547** PE ratio, Multiples valuation, DDM, income and capital returns, no explanation

A firm pays out all of its earnings as dividends. Because of this, the firm has no real growth in earnings, dividends or stock price since there is no re-investment back into the firm to buy new assets and make higher earnings. The dividend discount model is suitable to value this company.

The firm's revenues and costs are expected to increase by inflation in the foreseeable future. The firm has no debt. It operates in the services industry and has few physical assets so there is negligible depreciation expense and negligible net working capital required.

Which of the following statements about this firm's PE ratio is **NOT** correct? The PE ratio should:

Note: The inverse of x is 1/x.

**Question 56** income and capital returns, bond pricing, premium par and discount bonds

Which of the following statements about risk free government bonds is **NOT** correct?

**Hint:** Total return can be broken into income and capital returns as follows:

###\begin{aligned} r_\text{total} &= \frac{c_1}{p_0} + \frac{p_1-p_0}{p_0} \\ &= r_\text{income} + r_\text{capital} \end{aligned} ###

The capital return is the growth rate of the price.

The income return is the periodic cash flow. For a bond this is the coupon payment.

Which one of the following bonds is trading at a premium?

An investor bought two fixed-coupon bonds issued by the same company, a zero-coupon bond and a 7% pa semi-annual coupon bond. Both bonds have a face value of $1,000, mature in 10 years, and had a yield at the time of purchase of 8% pa.

A few years later, yields fell to 6% pa. Which of the following statements is correct? Note that a capital gain is an increase in price.

In these tough economic times, central banks around the world have cut interest rates so low that they are practically zero. In some countries, government bond yields are also very close to zero.

A three year government bond with a face value of $100 and a coupon rate of 2% pa paid semi-annually was just issued at a yield of 0%. What is the price of the bond?

Below are some statements about loans and bonds. The first descriptive sentence is correct. But one of the second sentences about the loans' or bonds' prices is not correct. Which statement is **NOT** correct? Assume that interest rates are positive.

Note that coupons or interest payments are the periodic payments made throughout a bond or loan's life. The face or par value of a bond or loan is the amount paid at the end when the debt matures.

**Question 108** bond pricing, zero coupon bond, term structure of interest rates, forward interest rate

An Australian company just issued two bonds:

- A 1 year zero coupon bond at a yield of 10% pa, and
- A 2 year zero coupon bond at a yield of 8% pa.

What is the forward rate on the company's debt from years 1 to 2? Give your answer as an APR compounding every 6 months, which is how the above bond yields are quoted.

Which of the following statements about yield curves is **NOT** correct?

You're trying to save enough money to buy your first car which costs $2,500. You can save $100 at the end of each month starting from now. You currently have no money at all. You just opened a bank account with an interest rate of 6% pa payable monthly.

How many months will it take to save enough money to buy the car? Assume that the price of the car will stay the same over time.

A student won $**1**m in a lottery. Currently the money is in a bank account which pays interest at **6**% pa, given as an APR compounding per month.

She plans to spend $**20,000** at the **beginning** of every month from now on (so the first withdrawal will be at t=0). After each withdrawal, she will check how much money is left in the account. When there is less than $**500,000** left, she will donate that remaining amount to charity.

In how many months will she make her last withdrawal and donate the remainder to charity?

In Australia, domestic university students are allowed to buy concession tickets for the bus, train and ferry which sell at a discount of **50**% to full-price tickets.

The Australian Government do not allow international university students to buy concession tickets, they have to pay the full price.

Some international students see this as unfair and they are willing to pay for fake university identification cards which have the concession sticker.

What is the most that an international student would be willing to pay for a fake identification card?

Assume that international students:

- consider buying their fake card on the morning of the first day of university from their neighbour, just before they leave to take the train into university.
- buy their weekly train tickets on the morning of the first day of each week.
- ride the train to university and back home again every day seven days per week until summer holidays
**40**weeks from now. The concession card only lasts for those 40 weeks. Assume that there are**52**weeks in the year for the purpose of interest rate conversion. - a single full-priced one-way train ride costs $
**5**. - have a discount rate of
**11**% pa, given as an effective annual rate.

Approach this question from a purely financial view point, ignoring the illegality, embarrassment and the morality of committing fraud.

You just entered into a fully amortising home loan with a principal of $**600,000**, a variable interest rate of **4.25**% pa and a term of **25** years.

Immediately after settling the loan, the variable interest rate suddenly falls to **4**% pa! You can't believe your luck. Despite this, you plan to continue paying the same home loan payments as you did before. How long will it now take to pay off your home loan?

Assume that the lower interest rate was granted immediately and that rates were and are now again expected to remain constant. Round your answer up to the nearest whole month.

**Question 455** income and capital returns, payout policy, DDM, market efficiency

A fairly priced **unlevered** firm plans to pay a dividend of $**1** next year (t=1) which is expected to grow by **3**% pa every year after that. The firm's required return on equity is **8**% pa.

The firm is thinking about reducing its future dividend payments by **10**% so that it can use the extra cash to invest in more projects which are expected to return **8**% pa, and have the same risk as the existing projects. Therefore, next year's dividend will be $**0.90**. No new equity or debt will be issued to fund the new projects, they'll all be funded by the cut in dividends.

What will be the stock's new annual **capital** return (proportional increase in price per year) if the change in payout policy goes ahead?

Assume that payout policy is irrelevant to firm value (so there's no signalling effects) and that all rates are effective annual rates.

You have $**100,000** in the bank. The bank pays interest at **10**% pa, given as an effective annual rate.

You wish to consume **half** as much now (t=0) as in one year (t=1) and have nothing left in the bank at the end.

How much can you consume at time zero and one? The answer choices are given in the same order.

**Question 180** equivalent annual cash flow, inflation, real and nominal returns and cash flows

Details of two different types of light bulbs are given below:

- Low-energy light bulbs cost $3.50, have a life of nine years, and use about $1.60 of electricity a year, paid at the end of each year.
- Conventional light bulbs cost only $0.50, but last only about a year and use about $6.60 of energy a year, paid at the end of each year.

The real discount rate is 5%, given as an effective annual rate. Assume that all cash flows are real. The inflation rate is 3% given as an effective annual rate.

Find the Equivalent Annual Cost (EAC) of the low-energy and conventional light bulbs. The below choices are listed in that order.

A share currently worth $**100** is expected to pay a constant dividend of $**4** for the next **5** years with the first dividend in one year (t=1) and the last in 5 years (t=5).

The total required return is **10**% pa.

What do you expected the share price to be in **5** years, just **after** the dividend at that time has been paid?

Find Candys Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Candys Corp | ||

Income Statement for | ||

year ending 30th June 2013 | ||

$m | ||

Sales | 200 | |

COGS | 50 | |

Operating expense | 10 | |

Depreciation | 20 | |

Interest expense | 10 | |

Income before tax | 110 | |

Tax at 30% | 33 | |

Net income | 77 | |

Candys Corp | ||

Balance Sheet | ||

as at 30th June | 2013 | 2012 |

$m | $m | |

Assets | ||

Current assets | 220 | 180 |

PPE | ||

Cost | 300 | 340 |

Accumul. depr. | 60 | 40 |

Carrying amount | 240 | 300 |

Total assets | 460 | 480 |

Liabilities | ||

Current liabilities | 175 | 190 |

Non-current liabilities | 135 | 130 |

Owners' equity | ||

Retained earnings | 50 | 60 |

Contributed equity | 100 | 100 |

Total L and OE | 460 | 480 |

Note: all figures are given in millions of dollars ($m).

A firm has forecast its Cash Flow From Assets (CFFA) for this year and management is worried that it is too low. Which one of the following actions will lead to a higher CFFA for this year (t=0 to 1)? Only consider cash flows this year. Do not consider cash flows after one year, or the change in the NPV of the firm. Consider each action in isolation.

A company increases the proportion of debt funding it uses to finance its assets by issuing bonds and using the cash to repurchase stock, leaving assets unchanged.

Ignoring the costs of financial distress, which of the following statements is **NOT** correct:

Which one of the following will decrease net income (NI) but increase cash flow from assets (CFFA) in this year for a tax-paying firm, all else remaining constant?

Remember:

###NI = (Rev-COGS-FC-Depr-IntExp).(1-t_c )### ###CFFA=NI+Depr-CapEx - \Delta NWC+IntExp###Find Sidebar Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Sidebar Corp | ||

Income Statement for | ||

year ending 30th June 2013 | ||

$m | ||

Sales | 405 | |

COGS | 100 | |

Depreciation | 34 | |

Rent expense | 22 | |

Interest expense | 39 | |

Taxable Income | 210 | |

Taxes at 30% | 63 | |

Net income | 147 | |

Sidebar Corp | ||

Balance Sheet | ||

as at 30th June | 2013 | 2012 |

$m | $m | |

Cash | 0 | 0 |

Inventory | 70 | 50 |

Trade debtors | 11 | 16 |

Rent paid in advance | 4 | 3 |

PPE | 700 | 680 |

Total assets | 785 | 749 |

Trade creditors | 11 | 19 |

Bond liabilities | 400 | 390 |

Contributed equity | 220 | 220 |

Retained profits | 154 | 120 |

Total L and OE | 785 | 749 |

Note: All figures are given in millions of dollars ($m).

The cash flow from assets was:

Your friend is trying to find the net present value of an investment which:

- Costs $
**1**million initially (t=0); and - Pays a single positive cash flow of $
**1.1**million in one year (t=1).

The investment has a total required return of **10**% pa due to its moderate level of undiversifiable risk.

Your friend is aware of the importance of opportunity costs and the time value of money, but he is unsure of how to find the NPV of the project.

He knows that the opportunity cost of investing the $1m in the project is the expected gain from investing the money in shares instead. Like the project, shares also have an expected return of **10**% since they have moderate undiversifiable risk. This opportunity cost is $0.1m ##(=1m \times 10\%)## which occurs in one year (t=1).

He knows that the time value of money should be accounted for, and this can be done by finding the present value of the cash flows in one year.

Your friend has listed a few different ways to find the NPV which are written down below.

Method 1: ##-1m + \dfrac{1.1m}{(1+0.1)^1} ##

Method 2: ##-1m + 1.1m - 1m \times 0.1 ##

Method 3: ##-1m + \dfrac{1.1m}{(1+0.1)^1} - 1m \times 0.1 ##

Which of the above calculations give the correct NPV? Select the most correct answer.

A man is thinking about taking a day off from his casual painting job to relax.

He just woke up early in the morning and he's about to call his boss to say that he won't be coming in to work.

But he's thinking about the hours that he could work today (in the future) which are:

What is the net present value (NPV) of undertaking a full-time Australian undergraduate business degree as an Australian citizen? Only include the cash flows over the duration of the degree, ignore any benefits or costs of the degree after it's completed.

Assume the following:

- The degree takes
**3**years to complete and all students pass all subjects. - There are
**2**semesters per year and**4**subjects per semester. - University fees per subject per semester are
**$1,277**, paid at the**start**of each semester. Fees are expected to remain constant in real terms for the next 3 years. - There are
**52**weeks per year. - The first semester is just about to start (t=0). The first semester lasts for 19 weeks (t=
**0**to**19**). - The second semester starts immediately afterwards (t=19) and lasts for another 19 weeks (t=
**19**to**38**). - The summer holidays begin after the second semester ends and last for
**14**weeks (t=**38**to**52**). Then the first semester begins the next year, and so on. - Working full time at the grocery store instead of studying full-time pays
**$20**/hr and you can work**35**hours per week. Wages are paid at the**end**of each week and are expected to remain constant in real terms. - Full-time students can work full-time during the summer holiday at the grocery store for the same rate of $20/hr for 35 hours per week.
- The discount rate is
**9.8%**pa. All rates and cash flows are real. Inflation is expected to be**3%**pa. All rates are effective annual.

The NPV of costs from undertaking the university degree is:

Find the cash flow from assets (CFFA) of the following project.

One Year Mining Project Data | ||

Project life | 1 year | |

Initial investment in building mine and equipment | $9m | |

Depreciation of mine and equipment over the year | $8m | |

Kilograms of gold mined at end of year | 1,000 | |

Sale price per kilogram | $0.05m | |

Variable cost per kilogram | $0.03m | |

Before-tax cost of closing mine at end of year | $4m | |

Tax rate | 30% | |

Note 1: Due to the project, the firm also anticipates finding some rare diamonds which will give before-tax revenues of $1m at the end of the year.

Note 2: The land that will be mined actually has thermal springs and a family of koalas that could be sold to an eco-tourist resort for an after-tax amount of $3m right now. However, if the mine goes ahead then this natural beauty will be destroyed.

Note 3: The mining equipment will have a book value of $1m at the end of the year for tax purposes. However, the equipment is expected to fetch $2.5m when it is sold.

Find the project's CFFA at time zero and one. Answers are given in millions of dollars ($m), with the first cash flow at time zero, and the second at time one.

Value the following business project to manufacture a new product.

Project Data | ||

Project life | 2 yrs | |

Initial investment in equipment | $6m | |

Depreciation of equipment per year | $3m | |

Expected sale price of equipment at end of project | $0.6m | |

Unit sales per year | 4m | |

Sale price per unit | $8 | |

Variable cost per unit | $5 | |

Fixed costs per year, paid at the end of each year | $1m | |

Interest expense per year | 0 | |

Tax rate | 30% | |

Weighted average cost of capital after tax per annum | 10% | |

**Notes**

- The firm's current assets and current liabilities are $3m and $2m respectively right now. This net working capital will not be used in this project, it will be used in other unrelated projects.

Due to the project, current assets (mostly inventory) will grow by $2m initially (at t = 0), and then by $0.2m at the end of the first year (t=1).

Current liabilities (mostly trade creditors) will increase by $0.1m at the end of the first year (t=1).

At the end of the project, the net working capital accumulated due to the project can be sold for the same price that it was bought. - The project cost $0.5m to research which was incurred one year ago.

**Assumptions**

- All cash flows occur at the start or end of the year as appropriate, not in the middle or throughout the year.
- All rates and cash flows are real. The inflation rate is 3% pa.
- All rates are given as effective annual rates.
- The business considering the project is run as a 'sole tradership' (run by an individual without a company) and is therefore eligible for a 50% capital gains tax discount when the equipment is sold, as permitted by the Australian Tax Office.

What is the expected net present value (NPV) of the project?

Your friend just bought a house for $400,000. He financed it using a $320,000 mortgage loan and a deposit of $80,000.

In the context of residential housing and mortgages, the 'equity' tied up in the value of a person's house is the value of the house less the value of the mortgage. So the initial equity your friend has in his house is $80,000. Let this amount be E, let the value of the mortgage be D and the value of the house be V. So ##V=D+E##.

If house prices suddenly fall by **10**%, what would be your friend's percentage change in equity (E)? Assume that the value of the mortgage is unchanged and that no income (rent) was received from the house during the short time over which house prices fell.

Remember:

### r_{0\rightarrow1}=\frac{p_1-p_0+c_1}{p_0} ###

where ##r_{0-1}## is the return (percentage change) of an asset with price ##p_0## initially, ##p_1## one period later, and paying a cash flow of ##c_1## at time ##t=1##.

Interest expense (IntExp) is an important part of a company's income statement (or 'profit and loss' or 'statement of financial performance').

How does an **accountant** calculate the annual interest expense of a fixed-coupon bond that has a liquid secondary market? Select the most correct answer:

Annual interest expense is equal to:

There are many ways to calculate a firm's free cash flow (FFCF), also called cash flow from assets (CFFA). Some include the annual interest tax shield in the cash flow and some do not.

Which of the below FFCF formulas include the interest tax shield in the cash flow?

###(1) \quad FFCF=NI + Depr - CapEx -ΔNWC + IntExp### ###(2) \quad FFCF=NI + Depr - CapEx -ΔNWC + IntExp.(1-t_c)### ###(3) \quad FFCF=EBIT.(1-t_c )+ Depr- CapEx -ΔNWC+IntExp.t_c### ###(4) \quad FFCF=EBIT.(1-t_c) + Depr- CapEx -ΔNWC### ###(5) \quad FFCF=EBITDA.(1-t_c )+Depr.t_c- CapEx -ΔNWC+IntExp.t_c### ###(6) \quad FFCF=EBITDA.(1-t_c )+Depr.t_c- CapEx -ΔNWC### ###(7) \quad FFCF=EBIT-Tax + Depr - CapEx -ΔNWC### ###(8) \quad FFCF=EBIT-Tax + Depr - CapEx -ΔNWC-IntExp.t_c### ###(9) \quad FFCF=EBITDA-Tax - CapEx -ΔNWC### ###(10) \quad FFCF=EBITDA-Tax - CapEx -ΔNWC-IntExp.t_c###The formulas for net income (NI also called earnings), EBIT and EBITDA are given below. Assume that depreciation and amortisation are both represented by 'Depr' and that 'FC' represents fixed costs such as rent.

###NI=(Rev - COGS - Depr - FC - IntExp).(1-t_c )### ###EBIT=Rev - COGS - FC-Depr### ###EBITDA=Rev - COGS - FC### ###Tax =(Rev - COGS - Depr - FC - IntExp).t_c= \dfrac{NI.t_c}{1-t_c}###A firm has a debt-to-assets ratio of 50%. The firm then issues a large amount of equity to raise money for new projects of similar systematic risk to the company's existing projects. Assume a classical tax system. Which statement is correct?

**Question 337** capital structure, interest tax shield, leverage, real and nominal returns and cash flows, multi stage growth model

A fast-growing firm is suitable for valuation using a multi-stage growth model.

It's **nominal** unlevered cash flow from assets (##CFFA_U##) at the end of this year (**t=1**) is expected to be $**1** million. After that it is expected to grow at a rate of:

**12**% pa for the next two years (from t=1 to 3),**5**% over the fourth year (from t=3 to 4), and**-1**% forever after that (from t=4 onwards). Note that this is a negative one percent growth rate.

Assume that:

- The nominal WACC
**after**tax is**9.5**% pa and is not expected to change. - The nominal WACC
**before**tax is**10**% pa and is not expected to change. - The firm has a target debt-to-
**equity**ratio that it plans to maintain. - The inflation rate is
**3**% pa. - All rates are given as
**nominal**effective annual rates.

What is the levered value of this fast growing firm's assets?

A firm has a debt-to-equity ratio of 25%. What is its debt-to-assets ratio?

Diversification in a portfolio of two assets works best when the correlation between their returns is:

All things remaining equal, the variance of a portfolio of two positively-weighted stocks **rises** as:

Two risky stocks A and B comprise an equal-weighted portfolio. The correlation between the stocks' returns is 70%.

If the variance of stock A **increases** but the:

- Prices and expected returns of each stock stays the same,
- Variance of stock B's returns stays the same,
- Correlation of returns between the stocks stays the same.

Which of the following statements is **NOT** correct?

**Question 556** portfolio risk, portfolio return, standard deviation

An investor wants to make a portfolio of two stocks A and B with a target expected portfolio return of **12**% pa.

- Stock A has an expected return of
**10**% pa and a standard deviation of**20**% pa. - Stock B has an expected return of
**15**% pa and a standard deviation of**30**% pa.

The correlation coefficient between stock A and B's expected returns is **70**%.

What will be the annual standard deviation of the portfolio with this 12% pa target return?

What is the correlation of a variable X with itself?

The corr(X, X) or ##\rho_{X,X}## equals:

Let the standard deviation of returns for a share per month be ##\sigma_\text{monthly}##.

What is the formula for the standard deviation of the share's returns per year ##(\sigma_\text{yearly})##?

Assume that returns are independently and identically distributed (iid) so they have zero auto correlation, meaning that if the return was higher than average today, it does not indicate that the return tomorrow will be higher or lower than average.

A stock's correlation with the market portfolio increases while its total risk is unchanged. What will happen to the stock's expected return and systematic risk?

Assets A, B, M and ##r_f## are shown on the graphs above. Asset M is the market portfolio and ##r_f## is the risk free yield on government bonds. Assume that investors can borrow and lend at the risk free rate. Which of the below statements is **NOT** correct?

A stock has a beta of **1.5**. The market's expected total return is **10**% pa and the risk free rate is **5**% pa, both given as effective annual rates.

In the last 5 minutes, bad economic news was released showing a higher chance of recession. Over this time the share market **fell** by **1**%. The risk free rate was unchanged.

What do you think was the stock's historical return over the last 5 minutes, given as an effective 5 minute rate?

A stock has a beta of **1.5**. The market's expected total return is **10**% pa and the risk free rate is **5**% pa, both given as effective annual rates.

Over the last year, bad economic news was released showing a higher chance of recession. Over this time the share market **fell** by **1**%. So ##r_{m} = (P_{0} - P_{-1})/P_{-1} = -0.01##, where the current time is zero and one year ago is time -1. The risk free rate was unchanged.

What do you think was the stock's historical return over the **last year**, given as an effective annual rate?

**Question 418** capital budgeting, NPV, interest tax shield, WACC, CFFA, CAPM

Project Data | ||

Project life | 1 year | |

Initial investment in equipment | $8m | |

Depreciation of equipment per year | $8m | |

Expected sale price of equipment at end of project | 0 | |

Unit sales per year | 4m | |

Sale price per unit | $10 | |

Variable cost per unit | $5 | |

Fixed costs per year, paid at the end of each year | $2m | |

Interest expense in first year (at t=1) | $0.562m | |

Corporate tax rate | 30% | |

Government treasury bond yield | 5% | |

Bank loan debt yield | 9% | |

Market portfolio return | 10% | |

Covariance of levered equity returns with market | 0.32 | |

Variance of market portfolio returns | 0.16 | |

Firm's and project's debt-to-equity ratio |
50% | |

**Notes**

- Due to the project, current assets will increase by $
**6**m now (t=0) and fall by $**6**m at the end (t=1). Current liabilities will not be affected.

**Assumptions**

- The debt-to-equity ratio will be kept constant throughout the life of the project. The amount of interest expense at the end of each period has been correctly calculated to maintain this constant debt-to-equity ratio.
- Millions are represented by 'm'.
- All cash flows occur at the start or end of the year as appropriate, not in the middle or throughout the year.
- All rates and cash flows are real. The inflation rate is 2% pa. All rates are given as effective annual rates.
- The project is undertaken by a firm, not an individual.

What is the net present value (NPV) of the project?

**Question 721** mean and median returns, return distribution, arithmetic and geometric averages, continuously compounding rate

Fred owns some Commonwealth Bank (CBA) shares. He has calculated CBA’s monthly returns for each month in the past 20 years using this formula:

###r_\text{t monthly}=\ln \left( \dfrac{P_t}{P_{t-1}} \right)###He then took the arithmetic average and found it to be **1**% per month using this formula:

He also found the standard deviation of these monthly returns which was **5**% per month:

Which of the below statements about Fred’s CBA shares is **NOT** correct? Assume that the past historical average return is the true population average of future expected returns.

**Question 722** mean and median returns, return distribution, arithmetic and geometric averages, continuously compounding rate

Here is a table of stock prices and returns. Which of the statements below the table is **NOT** correct?

Price and Return Population Statistics |
||||

Time | Prices | LGDR | GDR | NDR |

0 | 100 | |||

1 | 50 | -0.6931 | 0.5 | -0.5 |

2 | 100 | 0.6931 | 2 | 1 |

Arithmetic average | 0 | 1.25 | 0.25 | |

Arithmetic standard deviation | 0.9802 | 1.0607 | 1.0607 | |

A company announces that it will pay a dividend, as the market expected. The company's shares trade on the stock exchange which is open from 10am in the morning to 4pm in the afternoon each weekday. When would the share price be expected to fall by the amount of the dividend? Ignore taxes.

The share price is expected to fall during the: